The Securities and Exchange Commission (SEC) Private Fund Adviser (PFA) rules being overturned has led many firms to pause activities while they await next steps from the SEC.
In August 2023, the SEC announced new rules and rule amendments to enhance the regulation of private fund advisers and update the existing compliance rules that apply to all investment advisers.
A group of industry bodies sued to challenge the rules, because in their view, they would be “unduly burdensome” and “threatened to fundamentally change how they did business[1].” In June 2024, the New Orleans-based Fifth U.S. Circuit Court of Appeals agreed, deciding that the SEC had indeed exceeded its authority by adopting the rule. There’s no doubt that the judgment added complexity to the future of the PFA rules for firms that have been preparing for them since last year.
What is likely to happen next?
Many firms have welcomed the pause the judgment has provided. It has allowed them to defer additional operational costs, and they’re relieved that far-reaching changes are no longer required to be delivered within a short timeframe. Some have paused all the activity they’ve begun so far, although they will keep a close eye on updates from the SEC.
In terms of timeframes, it’s unlikely that there will be a great deal of urgent action undertaken by the SEC in the next 12 months, especially now that it has allowed the first deadline to request a rehearing of the rules to pass.
The change in legal status on the rules will provide breathing space for firms to continue work in areas such as enhanced client reporting and data management under less pressured conditions.
Private firms historically have competed based on their investment teams and fund performance, and this will continue to be the case. However, investors that want enhanced reporting and disclosures will continue to press and negotiate for those improvements.
Our upcoming research with private funds advisory firms found that in the first quarter of 2024, more than two-thirds (70%) said that their firm was already completely or mostly prepared for the proposed PFA rules, while 77% said they thought the industry as a whole was completely or mostly prepared.
As such, the direction of travel for private funds advisory firms will likely be to improve the quality of the data that they use for all aspects of their businesses, including transparent client reporting. As we saw from our research, the majority of firms surveyed are on this path, and see the benefits of embedding reporting and audits into business as usual, rather than just adopting them in response to new regulation.
How should firms prepare for the SEC’s next move?
While the SEC considers its next steps, we encourage firms to continue enhancing their data management and reporting strategies to meet the future needs of clients, whether the rules are amended or removed altogether.
We believe many firms will move forward with elements of the PFA rules that will increase the long-requested transparency that LPs are looking for, as well as processes that are considered to be best practice. For example:
- Provide quarterly financial statements; especially with additional information on management fee calculations and waivers, carry allocations, and performance metrics
- Provide audited annual financial statements; particularly where valuations are meaningful to investors
- Enhance the statement of partners’ capital to break out any caption that is not allocated pro rata and provide statements that show year-to-date and inception-to-date partner information
- Address the fairness of preferential treatment relating to redemption rights and exclusive insight into portfolio holdings
- Comply with recordkeeping rules related to all of the above so firms can minimize potential remediation if and when a portion of rules do come back
Each firm should determine what they consider to be industry best practice, addressing current and future investors’ most frequent questions and requests for information. They can then seek support from experienced service providers to smooth the way forward.
How CSC can help
By partnering with CSC, private capital fund managers can leverage our extensive experience and innovative solutions to drive operational excellence and achieve strategic objectives. We understand the unique challenges faced by private capital funds, enabling us to tailor solutions that meet their specific needs. We implement best practices in fund administration, from compliance and risk management to financial reporting and investor relations, ensuring that fund operations are not only efficient but transparent and trustworthy.
CSC’s advanced technology platforms offer integrated systems and real-time analytics, giving fund managers and investors a clear view of portfolio performance, expense allocations, and liquidity metrics. CSC has the expense management technology needed to calculate and record expense allocations and payments at the fund level; the accounting technology and expertise to allocate and track expenses, rebates, waivers, and offsets at the LP level to provide enhanced reporting; and the deep experience in preparing quarterly financial reports and working with auditors.
Visit our website to learn more about how CSC can help private fund advisors.
[1] cnbc.com/2024/06/05/us-appeals-court-rejects-sec-oversight-rule-for-private-equity-hedge-funds.html
